Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

Tuesday, June 21, 2011

Senators Question IRS Gift Tax Enforcement

You may have read that the IRS has decided to pursue Section 501(c)(4) organizations. This beggars the question: what is a 501((c)(4) organization?

The (c)(4) is a tax-exempt. That is not saying much, as there are over two dozen types of tax-exempts in the Internal Revenue Code. So what is different about this flavor of tax exempt?

The( c)(4) must not be organized for profit and must be operated exclusively for the promotion of social welfare. Examples of (c)(4)s are AARP and the National Association for the Advancement of Colored People. You may also remember MoveOn.org and America Coming Together.

A (c)(4) may further its social welfare purposes through lobbying without jeopardizing its exempt status as long as it is consistent with the organization’s purpose. It cannot however be the organization’s primary activity. If it is, then one should consider a Section 527 organization.

Are donations to a (c)(4) deductible? That depends. Donations to 501(c)(4)s that are public entities (such as a volunteer fire station) are deductible. Donations to other (c)(4)s are not deductible.

So what has happened to draw the IRS’ attention? Tax advisors such as me have known for a long time that donations to a (c)(4) are not deductible, and we make adjustments when a client includes these amounts in a list of contributions. The IRS has now decided to pursue the (c)(4)s with the argument that contributions are taxable gifts by the donors.

A taxable gift? This is a new issue to me, and I have been at this for a while.

It has caught the Senate’s attention. Six senators from the Finance Committee recently wrote a letter to IRS Commissioner Shulman. The Finance Committee writes tax law in conjunction with the House Ways and Means Committee. The Senators wrote (in part):

The applicability of gift taxes to 501(c)(4) contributions is ambiguous. Historically, the IRS has deliberately opted against vigorous enforcement of the gift tax on 501(c)(4) contributions. There are good reasons for this. First, it is unclear if contributions to these organizations are eligible for the gift tax given their gratuitous nature, and the fact that the donations are made with the expectation that the organization will work to advance the donor’s policy views. Moreover, these contributions are clearly not designed for tax planning purposes or to avoid the estate tax. Most importantly, however, enforcement of gift taxes on contributions to 501(c)(4) organizations engaged in public policy debate runs an unacceptable risk of chilling political speech, which receives the highest level of constitutional protection under the First Amendment

This pattern of nonenforcement over a period of nearly three decades, coupled with the troubling issues regarding the adverse impact that enforcement might have on the exercise of constitutionally protected rights, raises important questions regarding the timing of the decision to enforce the gift tax on these contributions. Retroactive enforcement of the gift tax in this highly politicized environment raises legitimate concerns and demands further explanation."

The statement by IRS spokeswoman Michelle Eldridge did not assuage these concerns and left us with only more questions. According to Eldridge, “[a]ll of the decisions involving these cases were made by career civil servants without any influence from anyone outside the IRS.” We would expect that decisions regarding particular enforcement actions would be made by career civil servants. The more pressing question, not answered to date, is whether political appointees inside or outside the IRS were involved in any way in the decision to prioritize this category of cases."

I understand that (c)(4)s are not supposed to be piggybanks, but are there really enough tax dollars here for the IRS to prioritize this issue?

I was too young, but I have understood that President Nixon used the IRS as a political weapon against his opponents. In a country where half the population does not trust the current President to do the right thing, it is unfortunate to have the IRS call its neutrality into question. You can accept or hate the IRS, but it is imperative that the IRS act and be perceived as a neutral entity.

One can argue that perhaps there is no good time for this type of action, but the observation remains that this is not a good time.

I will come back in a separate post with more detail on the tax issues raised by (c)(4)s.

About Me

Thirty years years in tax practice. It's a long time, and I have seen virtually everything short of the fabled tax-exempt unicorn. I was raised in Tampa, went to school in Missouri, taught at Eastern Kentucky University, lived in Georgia, got pulled to Cincinnati when I married, have in-laws in England and a daughter going to the University of Tennessee. I am not sure where I will wind up next, but I hope there is better weather.